Directions to Raise Price to Improve Revenues and Margins
The Improve Pricing section of StrategyStreet helps you use pricing to improve your profitability by increasing your revenues from customers. You might improve profitability by raising prices to increase revenues and the gross margins in your business.
You should consider how changes to your pricing approach might apply to each of your key customer segments. If you haven’t done so, we recommend that you identify the customer segments in your business by using the Diagnose/Segments section of StrategyStreet to identify the Core customers in your market. You might then use our Improve/Segments section to identify the emerging needs of these key customers. Your price brainstorming sessions will be most effective if you have a clear understanding of the needs of your customer segments. At a minimum, we recommend that you become familiar with the concepts presented in these videos:
- Video #72: Overview of Pricing Part 1: How to Look
- Video #73: Overview of Pricing Part 2: What to Expect
- Video #74: Overview of Pricing Part 3: What to Do
- Video #78: Competing Against Low-End Competition Part 1
- Video #79: Competing Against Low-End Competition Part 2
As you evaluate each potential change in pricing, make a rough calculation of the impact of the potential change on the net life cycle costs the customer incurs with your product compared to competitive products.
We have organized these innovation ideas into three choices and their supporting actions. We illustrate the actions with many examples. These are practical real-world examples. The examples we offer to support each item on the outline come from the experiences of many other companies in other industries. The purpose of these examples is to broaden your innovation ideas. Each example lists the SIC of the industry, the year, and a short description of a situation where the pricing concept is used or implied in the company’s actions.
Each pricing action is distinct from others. However, the innovation examples are not meant to be mutually exclusive nor collectively exhaustive. You may find that you generate new ideas in one brainstorming step that really belong in another. Nevertheless, the new idea is the objective, so anything that helps you generate new ideas is of benefit to you.
We suggest you use this section of the web site as follows:
- Open the portion of the innovation outline of interest to you.
- Create innovation ideas to innovate your current pricing approach for your customers, using only the outline.
- Use the examples supporting the outline item in order to expand your range of ideas.
IDENTIFY OPPORTUNITIES TO RAISE PRICE. You raise prices to improve margins where the revenue and margin gains from sales to continuing customers are greater than the margin losses from defecting customers. Shortcut to Innovation>>
To raise Prices effectively, the company makes three sequential choices:
- CHOICE 1: Select the objective of the price increase
- CHOICE 2: Isolate the segments who must pay the price increase
- CHOICE 3: Use the components of price to further control the extent of the higher price
CHOICE 1: SELECT THE OBJECTIVE OF THE PRICE INCREASE
The company improves its margins by changing the Value offered to the customer and the Cost of providing that Value. Value for the customer is the combination of Performance and Price in the company’s offering. The company may either increase or decrease the Value for the customer to improve its revenues. But, it will always reduce its Cost as a percentage of its new Price. Accordingly, there are five practical objectives that improve the company’s margins:
- Raise Price with no change in Performance and Cost. Companies who operate in an environment where they have very strong brand reputations, or where there is a shortage of capacity to meet demand, may raise prices without improving Performance and its Cost. The customer receives less Value. Illustrative Examples>>
- Price the same, reduce Performance and Cost. At first glance, this does not seem to be a Price increase. It is effectively a Price increase because the Performance and the Cost of Performance both decline, improving the company’s margins. The customer receives less Value. As in “A” above, the company must be in a strong competitive position to succeed at this objective. Illustrative Examples>>
- Raise Price, raise Performance and Cost by smaller amount. Here the company increases its margins by raising Prices by more than its Costs increase to support a better Performance. This objective often leads to a new, higher Price Point. The customer usually receives better net Value. Illustrative Examples>>
- Raise Price, recover the increased Cost of current Performance. Here, the company increases its Prices to offset directly Cost increases in its Performance package. The company does not improve its margins directly. Instead, its margins are higher, due to this Price increase, than they would have been without the Price increase. The effect on Value for the customer depends on the change in the customer’s full system cost compared to the increase in Price of the product. Illustrative Examples>>
- Raise Price, reduce Performance and its Cost. In this unusual situation, the company raises Price and reduces its Performance for the customer and the Cost which supports the Performance. The customer Value declines. The company’s margins increase. This objective carries the risk of a decline in the company’s market share. Illustrative Examples>>
CHOICE 2: ISOLATE THE SEGMENTS WHO MUST PAY THE PRICE INCREASE
To succeed, the company’s Price increase must not be countered by a lower Price offering from a competitor. The competitor is unlikely to counter the company’s Price increase if:
- The competitor does not know of the Price increase.
- The competitor does not have the capacity to respond to the Price increase with a lower Price.
- The competitor does not have the will to risk its profits by offering a lower Price than the company offers.
Accordingly, the company isolates segments to receive the higher Price where one or more of these conditions exist with competition. These include the following segments:
A. All segments: In some cases, the company will raise its Prices with all of its current customer segments. This segmentation is common where the company must recover costs that are rising across the industry. Illustrative Examples>>
B. Customer segments who are captive to the company: Some customer segments are effectively captives of the company due to their strong preference for one or more components of the company’s current Performance package. These segments include customers with strong preferences for such benefits as:
- A unique Function, where the company offers the user a feature that others do not, or cannot, offer. Illustrative Examples>>
- A unique Reliability, where the company offers the consumer a unique brand name, signifying the quality of the product and the company’s standing behind the product, or where the company offers a channel of distribution certainty of long-term and consistent market presence of the seller with the channel or the ability to deliver product as, and when, ordered. Illustrative Examples>>
- A unique Convenience, where the company offers the buyer the easiest purchase and installation process. This segment may include customers who simply prefer not to go to the effort of changing suppliers. Illustrative Examples>>
C. Segments of customers where competitors cannot counter the company’s change in Value: These segments may require a component of the product system. In other cases, the competitor would not even know of the change in Price and Performance. These include:
- Customer segments who require a specific product system component. This component would normally be part of a broader product system and usually not purchased separately from the product system. Illustrative Examples>>
- Customer segments who use a service or purchase a product on a specific occasion. These segments include customers who purchase at a particular season or who terminate their supplier relationships. Illustrative Examples>>
D. Segments of customers where competitors are likely to be unwilling to counter the company’s change in Value:
- Customer segments who purchase products with higher Cost components. Because these products have higher costs, they command higher prices. These segments are usually purchasing a higher Price Point. Illustrative Examples>>
- Customer segments with high servicing costs. These customers, often smaller customers in the market, have costs above those of the more attractive, larger, customers and must pay a higher price for their purchases. Illustrative Examples>>
- Customer segments making higher-than-average use of capacity. These customers are more intensive users of the company’s products and its capacity and, therefore, pay a higher-than-average price for their purchases. Illustrative Examples>>
- Customer segments purchasing during a period of unbalanced supply and demand. Customers who purchase when available capacity is low are unlikely to receive a lower price offer from a competitor, who would also face capacity constraints. Illustrative Examples>>
- Customer segments served by competitors likely to follow the Price increase. Customer segments who purchase in markets where industry leaders set Prices, which the remaining competitors typically follow, or where competitors are unwilling to use Price as a competitive weapon will see higher prices because of this lack of Price competition. Illustrative Examples>>
CHOICE 3: USE THE COMPONENTS OF PRICE TO FURTHER CONTROL THE EXTENT OF THE HIGHER PRICE
Every Price has at least three, and usually four, components: the Benefit Package, the Basis of Charge, the List Price and, often, one or more Optional Components of Price. The company may use these components to further control the extent of the higher Price in the market. The company increases its margins by changing these components as follows:
A. Change the Benefit Package: This package of benefits is the Performance part of the Value proposition the company offers the customer. This package includes all the Function, Reliability and Convenience benefits at the product Price Point. The company may reach a new higher Price by changing the Function, the Reliability, the Convenience or any combination of the three at the same time as it changes price. It may also reduce benefits to improve margins.
- Change Function and Price together Illustrative Examples>>
- Change Reliability and Price together Illustrative Examples>>
- Change Convenience and Price together Illustrative Examples>>
B. Change the Basis of Charge: The Basis of Charge is the unit measure the company uses to quantify the Price, or an optional component of the Price. A change in the Basis of Charge will often reflect changes in company costs, or changes in packaging. Frequently, this change in the Basis of Charge also produces a new product Price Point. Illustrative Examples>>
C. Change the List Price: The List Price is the company’s stated Price for a unit of the product as quantified by the Basis of Charge. This is the most common of the four major Components of Price that the company uses to raise its prices to a particular segment of customers. In many cases, where the company chooses to change only the List Price among its four Components of Price, the isolated customer segment, which must pay the higher Price, is sufficient to limit the extent of the higher Price. Illustrative Examples>>
D. Change the Optional Components of Price: These Optional Components of Price include several alternatives to obtain premium payments from customers, or to reduce the capital assets the company must use to support the customers. We have found several relatively common components that companies use to raise their effective prices. You may change these Optional Price Components as follows:
- Add an extra fee on top of the normal variable charge: This extra fee increases the company’s margins and usually reflects a separately identifiable cost in the company’s Performance offering. The company identifies previously free or lower priced benefits that have separately identifiable costs. The company then increases its margins by charging a fee on top of its normal variable charge to improve margins by covering the costs of the newly identified separate benefit. Illustrative Examples>>
- Shorten the normal payment term: By reducing the time the company allows the customer to pay for the product once it has been ordered or delivered, the company reduces the capital assets it must carry for the customer. This raises the customer’s capital costs to finance inventories while it reduces the company’s capital costs to support accounts receivable. The Value to the customer declines. Illustrative Examples>>
- Set or raise minimum purchase requirements: This Price Component assures the company of a minimum amount of sales to each customer. These changes require the customers to increase their minimum purchases and pay for any product that they do not take or use. This component raises the company’s margins by ensuring the company a minimum order from each customer. The Value for the customer declines because it must finance a larger inventory on its balance sheet. Illustrative Examples>>
- Eliminate forms of discount: Virtually all customer relationships involve some discount offer to the customer. The company may raise its prices by eliminating some, or all, forms of discount it offers its customers. This elimination of a discount raises the effective price the customer pays and the margins the company receives on the sale. Illustrative Examples>>
- Set limits on the usage of the product: The company may raise its effective Prices, especially with customers who use the product intensively, by setting limits on the amount of product the customer may use during a period of time. Illustrative Examples>>
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|For a greater overall perspective on this subject, we recommend the following related items:
|Perspectives: Since 1985, we have conducted an ongoing in-depth study of companies and industries who face particularly competitive marketplaces. This section of the website enables you to apply the results of this extensive research to your business situation.
|List of Pricing Policy Perspectives
|List of Price and Margin Levels Perspectives
|Symptoms and Implications: This section allows you to check current developments in your industry in order to understand their implications for the future of your marketplace.
|List of Pricing Policy Symptoms and Implications
|List of Price and Margin Levels Symptoms and Implications
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